Long Term Strategy and Discipline Wins!

There continues to be more and more media attention that the ‘buy and hold’ strategy is dead. That Modern Portfolio Theory no longer works. I just read an article stating that Modern Portfolio Theory has many flaws. This is another attempt by the Wall Street bullies to keep your money on the move.

The ‘experts’ proclaimed that market timing was the answer. Well guess what there is no perfect system. Resist the temptation to follow the hot system.

During my analysis of many portfolios. I have found many advisers misusing Modern Portfolio Theory. At least on the fixed income side. Many include high risk fixed income, like high yield bonds or long term corporate bonds. This just adds risk to the portfolio. If you want more risk increase the equity allocation.

Properly used, Modern Portfolio Theory uses fixed income to control risk. This is accomplished by using high quality, short term fixed income.

In addition, true investors are much better served using a passive management strategy and utilizing Modern Portfolio Theory and ‘buy and hold’. This strategy, over the long term will lead to success.

It should be emphasized that ‘buy and hold’ should really be ‘buy and rebalance’. ‘Buy and hold’ might signify set and forget and we must rebalance back to our target allocation periodically. This entails buying low and selling high, automatically.

When we rebalance we sell asset classes that have done well and buy asset classes that have done poorly, short term. Buy low, sell high. This is done periodically and eliminates the need to forecast the future.

In his 1993 letter to shareholders of Berkshire Hathaway, Warren Buffet counseled; “By periodically investing in a ‘passive’ fund….the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.” He repeated the advice 10 years later in the 2003 letter.

Mr. Buffet, in my opinion, was saying that trying to stock pick, market time and track record investing was ‘dumb’.

To be successful, investors, no matter how large, would be far better off using a passive strategy with Modern Portfolio Theory as part of the process. Modern Portfolio Theory is actually part of a larger strategy called Free Market Portfolio Theory.

Remember no strategy always looks like the right thing to do. We must continue to believe the free markets do work. Most importantly we must believe in our strategy and remain disciplined.

Jumping from one hot asset class to another, or another hot money manager to another will lead to poor results. Along with a tremendous amount of anxiety. In many cases it will lead to avoiding equities all together.